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July 1, 2011, 1:44 p.m. EDT
By Brett Arends, MarketWatch
BOSTON (MarketWatch) "” You may figure there is no earthly connection between the sudden release of Dominique Strauss-Kahn and your investment portfolio.
You'd be wrong.
What leaps out about the entire DSK case is the way, in our world of instant, all-pervasive electronic media, the entire world rushed to judgment.
Following the discovery of false statements from Dominique Strauss-Kahn's accuser, the case against the former IMF chief is now in jeopardy. Michael Rothfeld has the latest details. (Photo: Reuters)
When Strauss-Kahn was arrested, he was immediately assumed to be guilty. That assumption was nearly universal. Critics and commentators lined up to add their two cents' worth, even though few had any hard information to offer. Any contrarian voices were indignantly shouted down. Like Ben Stein's. He asked 10 questions about the case and was immediately pelted with rotten fruit.
In the terms of financial markets, there was a DSK guilt "bubble."
Now it turns out there are serious concerns about the accuser's credibility. Perhaps Strauss-Kahn is innocent after all. We don't yet know, one way or another. Read the latest on the case against Strauss-Khan.
But once again, a near-universal "consensus" is now in question.
We think we live in a golden age of information. We have the Internet, cable TV and satellite radio, Twitter feeds, Facebook updates and a constant stream of blogs. We have them everywhere, and all the time, on our computers, our phones and our iPads. We like to think this leads to more information and therefore better-informed judgments. But the reverse is often the case. Public opinion in the age of infinite media reminds me of the line by the English satirist Saki: "Children of Hyacinth's temperament don't know better as they grow older; they merely know more."
Far from making us wiser, smarter and better informed, modern technology is instead casting us back into the past. The electronic village is home to a lot of electronic lynch mobs and electronic witch trials.
What does this have to do with finance? Everything. Financial markets are simply the crowd in action. They reflect the weight of money and investment opinion. That is their strength, but that is also their flaw. The more I see mass judgments in the age of infinite media, the more I think it's a flaw.
Is deflation a threat? Suddenly there is a stampede into long-term government bonds. Or is inflation a threat? Suddenly there is a stampede into gold. Is Web 2.0 the future? Suddenly there is a stampede into dot-com stocks like LinkedIn Corp. /quotes/zigman/5131883/quotes/nls/lnkd LNKD +4.94% and soon Groupon Inc. Is the economy entering a soft patch? There is a rush out of stocks. The judgments become self-reinforcing. Contrarian voices are drowned out. The mob is frequently wrong, but never in doubt.
Our new information age is one of more volatility, more misjudgments, wild irrational pricing "” and huge bubbles that inflate, and then deflate, in a moment.
Yet despite all this, most investors still remain under the influence of an incredibly dangerous idea: The idea that the market is always right, or at least rational.
People who worship the market formally call it "the efficient-market hypothesis." It underpins so-called Modern Portfolio Theory that is used by most financial advisers, and indeed forms the core of the investing module for the Certified Financial Planner training program.
Even those who don't subscribe to this formally are under its influence. Time and again we see the public buying stocks after they have risen, or selling them after they have fallen, on the grounds that "everybody else" must know something. The advertisements tell us past performance is no guide to the future, but most people still act like it is. Our brains are hard-wired to follow the crowd. Frequently we follow it over the cliff.
There are some simple lessons from all this. The Dominique Strauss-Kahn case hammers them home.
We should never assume the crowd, or "everyone else," or the market is right or even rational. Five hundred ill-informed opinions don't amount to a hill of beans.
We should always listen to what contrarians have to say "” especially when they sound most ridiculous, and especially when they are being shouted down. We should never trust any judgments reached quickly.
In reaching our own conclusions, we should fight the urge to join the crowd. We should take our time, do our own homework and make up our own minds. There is no hurry.
We should always be willing to change our minds if need be. This is the hardest thing to do. We constantly have to remind ourselves that we could be wrong.
Next time someone tells you the market is rational and efficient, just remember the market is just the opinion of the crowd. Just how much weight do you really want to give it?
Brett Arends is a senior columnist for MarketWatch and a personal-finance columnist for the Wall Street Journal.
Brett Arends is an award-winning financial columnist with many years experience writing about markets, economics and personal finance in Europe and the U.S... Expand
Brett Arends is an award-winning financial columnist with many years experience writing about markets, economics and personal finance in Europe and the U.S. He has received an individual award from the Society of American Business Editors and Writers for his financial writing, and was part of the Boston Herald team that won two others. He was educated at Cambridge and Oxford Universities, and has worked as an analyst at McKinsey & Co. He is a Chartered Financial Consultant (ChFC) and Accredited Asset Management Specialist (AAMS). His latest book, "Storm Proof Your Money," has just been published by John Wiley & Co. Collapse
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